Hugh Hendry talking macro and China

It's been a while since I've mentioned Hugh Hendry but he's popped back up on YouTube recently.  After his positively raucous returns in the depth of the crisis he had a long period of very underwhelming returns and from his manner in this broadcast I'd guess a tough few years.

ft.com describes the decline in assets under management in 2014

As always I find him entertaining to watch.   He provides some of the reasons for his reversal of opinion on China as well.  Regardless whether you agree with him or not I suggest you listen.

source: http://www.macrobusiness.com.au/2016/04/hugh-hendrys-long-dark-night-of-the-soul/

The fiscal cliff of 1937

With all the current noise regarding the 'fiscal cliff' I thought a look back at when we had a real fiscal cliff would be interesting.

Steve Keen, an Australian economist I've mentioned before recently gave a presentation to members of Congress regarding the Fiscal Cliff of 1937.

Source: http://www.debtdeflation.com/blogs/2012/12/06/briefing-for-congress-on-the-fiscal-cliff-lessons-from-the-1930s/

In his presentation Mr. Keen describes the mechanism through which a dramatic tax increase coupled with an absolute cut in spending threw the US economy into a recession.  From 1937 to '38 tax receipts when up ~25% and spending was cut ~8%  While in the 1937 spending and taxes were a much smaller percentage of GDP, the large swings in their absolute numbers were enough to decrease the deficit from -2.5% to -0.1% or a change of 2.4% (source: White House)

Additionally the Federal Reserve shrank their balance sheet at the same time:

The wrong time to anti-QE
Source: Federal Reserve

The combination of Fiscal and Monetary tightening pushed the economy back into recession. (Vertical gray lines on above graph.)

Right now we are experiencing a similar situation: The US economy is working off the excesses of a burst credit bubble and federal spending and deficits are at an all time high.   

Spending and Taxes from 1930 on
Source: White House

As you can see above, spending is at at a peacetime high and taxes are near a post WWII low. (Both relative to GDP.) Combine the two and you have the largest peacetime deficit from 1900 onward. (The data from the White House doesn't go back any further than 1900, so there may be another time period before then however I doubt we have experienced peacetime 10+% budget deficits before.)

Today we can see the credit bubble bursting in a chronically high unemployment rate and sluggish GDP growth.  Unlike other downturns, our GDP did not rebound much. 

Real US GDP
Source: Federal Reserve

A ~2.5% GDP growth rate after coming out of a recession is quite low as compared to historical norms.

Raising taxes too quickly combined with actual spending cuts on an already slowly growing economy could send us immediately into a recession.  This is what has Wall Street in a current tizzy and is already hitting consumer confidence.

Predictions about the future are tricky, especially when politicians are involved.

How much taxes go up, and if there are any actual spending cuts will determine how much of a fiscal drag hits the economy in 2013.  Right now it's all speculation and I'm not going to try to predict what Congress and the President will eventually agree to, before or after January 1, but there are a few items which appear certain:

• Taxes will go up, but not as much as 1937 on a percentage basis
• Spending will most likely not decline on an absolute basis
• Federal spending is a much larger percentage of the economy than in 1937
• The Federal Reserve will NOT shrink its balance sheet in 2013

How much taxes will go up and on whom is the unknown and that is what is creating uncertainty in the mind of corporations and individuals.  Until we have clarity both the markets and consumer actions may be volatile.

Additional reading:

http://www.ritholtz.com/blog/2012/12/what-is-the-fiscal-cliff/

http://www.cringely.com/2012/12/16/dr-al-explains-the-so-called-so-called-fiscal-cliff/

http://soberlook.com/2012/11/putting-fiscal-cliff-in-perspective.html

I actually wrote about this 2+ years ago as I was studying the history of the Great Depression.
http://merrillovermatter.blogspot.com/2010/06/is-steep-yield-curve-leading-us-astray.html

Thanks to
 @mbusigin 1937 fed data
 @AlephBlog When is a 'cut' really a 'cut' in Washington speak (hint, not very often)    

End Date Bond ETF's followup -- More options on the menu

More than a year ago I highlighted a new twist on bond etfs called the end date bond etf.  Since then Ishare's end date muni etfs have grown to manage over 185 million in total through the 2012-2017 maturity spectrum.  Not bad.

Guggenheim also rolled out both a corporate bond and high yield end date etf series, providing a wider menu of risk. Guggenheim's corp etf's run from 2011 to 2017 while the high yield field provides a 2012 to 2015 maturity spectrum.   While the high yield etf's have gathered 144 million, the corporate funds have pulled in over 430 million with one fund, the 2013 Corporates (symbol BCSD) about to break 100 million.

Hopefully someone will introduce an end date bond etf series on US Treasuries and US Tips (Inflation protected) to round out the risk profiles available. (hint hint, nudge nudge)

A few caveats are needed regarding buying and selling these etfs

• They are still illiquid and the price can vary dramatically from the NAV of the underlying assets.  Check the fund description page and make sure you are not overpaying.
• Diversification does not eliminate risk.  The 2017 Guggenheim Corp fund contains a large slug of financial bonds. If we have another credit event like 2008 due to a European sovereign default you could see losses on these corporate bonds (and possibly junk bonds and muni bonds)  The price the market will give you will also fluctuate.
• Check when the bond etf actually 'matures'. Each fund complex has their own procedures and nuances as to when the funds will be distributed to shareholders.

While there are disadvantages to these (currently) illiquid etfs I find their introduction into the investing universe promising. Building a bond ladder will be much easier and cheaper with greater liquidity for smaller dollar amounts versus finding, researching and purchasing individual bonds.

End date etfs will also allow one to take advantage of rolldown in the bond market. With short rates at zero, as the maturity date approaches for a bond the yield will drop (setting credit risk aside) and thus the price rises and yield drops. Econompic explains the dynamics in greater detail.

Ishares highlights a few of these advantages in a video:

Additional reading:
Seeking Alpha guide to end date etfs
Ishares muni bond end date etf
Guggenheim menu of corp and junk end date etfs - (scroll down to bottom)

Disclsosure: The author does not own any end date etf's but is examining the muni bond etfs for purchase shortly.

Muni bond redux

Late last year I mentioned the relative thrashing muni bonds had experienced.  Fast forward to today and the mass defaults as predicted by Meredith Whitney are not occurring and muni bonds have experienced a nice rebound.  Let's look at some charts:

The ETF's MUB and IEF are great for comparing the two sectors as they have almost the same duration of 7.43 vs. 7.24. While they are not precisely the same (MUB's bonds are more smeared out along the maturity curve while IEF's are very compact) it is good enough for this discussion.

As you can see MUB is now outperforming IEF on a relative basis and the yield one receives from MUB remains higher than IEF with an estimated yield to maturity of 3.30% versus 2.86% Usually municipals bonds yield less than treasuries due to their tax free income but not right now.  Assuming a return to 'normal' with muni bonds yielding 80% of treasuries you'd need MUB to increase by approximately 7.5%

[The math:  80% of IEF's ytm = 2.29%
MUB yield change (3.30 - 2.29) * duration of 7.43 = 7.50 ]

This does not include the tax free coupon one would receive while you wait for the trade to complete and also assumes treasury rates remain stable.  I'm of the opinion treasury rates will also drop in the near future so you'd gain there as well.  All in all a relatively low risk / low reward trade but considering the equity markets have been going nowhere for a couple months I'll take it.  MUB is also starting to outperform SPY on a relative basis as well, go figure...

Reminder: I don't manage your money and this is not a complete part of my investment portfolio. I may not tell you when I close out the position.  This should not be construed as investment advice as I do not know your tolerance for risk, tax situation, need for income, etc. 


Disclosure: Long MUB in both personal and client accounts.

Additional reading:
Ishares MUB etf detail
Ishares IEF etf detail
Business Insider
JPMorgan's comments


Note: Another possible reason why MUB is outperforming is the light issuance schedule for muni bonds right now. This may be due to the previous rush to market while Build America Bonds were still possible before the 12/31/10 deadline or the current high relative yield environment for muni bonds.
Bond Buyer article #1  & Article #2  (ht MuniLass)

Something to watch in the new year

The year is wrapping up and the US stock market continues to grind higher in a Christmas rally. While the US is in a much calmer state as compared to a year ago, not all is well across the pond in Europe.

The fiscal crisis in the PIIGS of Europe (Portugal, Ireland, Italy, Greece, Spain) has not been 'fixed' in my opinion and will most likely move up to the headlines in America very shortly.

Here you can see a chart of the PIIGS bond yields  (Bloomberg) and they are not going in the right direction. The spike and fall in May 2010 was due to Greek financial difficulties and the spike in November was from Ireland. Note how much faster the fall in yields after the Ireland event has been retraced as compared to the Greek event.

As this chart shows the absolute yields and not the relative 'risk' of the PIIGS regions looking at the combined CDS for the PIIGS (Bloomberg) provides a clearer view of perceived risk.  It too is almost at new highs and could very well exceed previous peaks before the new year.    I suggest you keep an eye on both of these indicators and if you see them shooting higher you will most likely see weakness in the equity markets as well.

More thoughts on the muni market

My previous post on the muni market needed some more information.  (Ready, Fire, Aim)
Bond Girl over at self-evident.org highlights some recent events which most likely were the catalyst for the most recent downdraft in the muni market.

The pending expiration of the Build America Bond (BAB) program has pulled supply forward, and this is going to seesaw over the next several weeks.  Since the BAB program was initiated, most issuers have structured their new issues with the sense that they will go to either the tax-exempt or taxable market, whichever is more advantageous at the time. . . 

What is going on now is that muni issuers are scrambling to get deals done to take advantage of the program before it expires, and this is pulling the number of new issues that would ordinarily be coming to market forward.  So the looming expiration of the BAB program is creating the very conditions it was created to alleviate.

I suggest reading the entire article for some additional info on the current situation. As I mentioned in my previous post  it is unusual for muni bonds to trade at a higher yield to treasuries as the muni's have a tax benefit.  The current situation is unusual and bears further attention.

Some perspective on the muni bond market

There's been some recent news regarding how municipal bond prices are dropping and California is having some problems selling new muni debt.  Looking back one can see the relative drop in municipal bond prices is not new and its been going on since May.

Observing the ratio of the etf's MUB (nationwide muni bond fund) to IEF (7-10 year US Treasury bond fund) can be instructive as it shows the relative value of two bond funds with almost the same duration (7.58 vs 7.26)

The relative decline in MUB is more dramatic when observed in this fashion versus an absolute basis. Furthermore looking at each etf's yield is interesting:
MUB 12 month yield: 3.71%
IEF 12 month yield: 3.00%
In other words a tax free bond fund is yielding 71 basis points more than a treasury fund with the same interest rate risk.  This 'shouldn't be' as muni bonds are tax free and a safe investment, right?  The markets are telling you something here; the perceived credit risk of muni bonds is increasing.

Source:
Stockcharts MUB:IEF
etf MUB home page
etf IEF home page

edit:  I have a followup post to this entry which you should read as well.

China PMI comes in below expectations. Overnight stock futures down.

The Chinese Purchasing Managers Index (PMI) came in at 52.1 as reported by Chinadaily and looking at the market reaction it was below expectation.

SP 500 overnight futures are down ~0.8%
Gold down
Copper down
Bonds up
You can see delayed CME futures quotes if you want to watch the action tonight.

Another short term money market indicator

I recently posted about the TED spread and how it had been marching higher (Murphy's law struck of course and it promptly reversed course right after I mentioned it.)

Zerohedge recently posted about a similiar money market stress indicator in the Chinese banking sector that bears watching.  If you want to look at the 1 month Chinese interbank lending rate in there future, here's the direct Bloomberg link

End Date Bond ETF's -- A long time coming and a welcome addition

edit: I have a followup post to end date etf's here

Finally.  This is an ETF I've personally asked ETF complexes to create.  My prayers have finally been answered.  Ishares has come out with the first end date ETF series.

A quick explanation:  Until Ishares created the end date ETF's, all bond funds were perpetual.  If you purchased an etf with a target maturity the fund would always be purchasing and selling bonds within the target maturity band, credity quality criteria, etc.  If interest rates went up or down your fund value would go up and down accordingly but you'd never be sure how much your ETF would be worth in X number of years.

The end date ETF is different, the ETF is designed to expire at a specific date in the future.  From a financial planning perspective this is huge. Now you can build a 'bond ladder' with just a few purchases. With an end date ETF as the the expiration date approaches the volatility will decline as the duration decreases.

Buying muni bonds has always been a pain with huge spreads and taking lots of time to execute.  With the end date ETF's making adjustments will be very easy and quick and if you need to make minor changes in the future the spreads will be much tighter than buying and selling individual bonds.

One caveat, I would not buy them now. The premium to NAV is huge right now at more than 1.5%  The funds are also very small and the spreads are pretty wide.  Once the premium to NAV falls to fair value I will be a buyer of these funds for my clients and myself.

I can see why they created end date ETF's for the muni bond complex first as it is the most illiquid of the bond sectors. Hopefully they will be very successful and Ishares goes on to create end date ETF's for corporate, treasury, and TIP bonds.

Additional reading:
Investment News
Ishares.com end date 2017  ETF